Definition of Time value of an option

Time value of an option

The portion of an option's premium that is based on the amount of time remaining
until the expiration date of the option contract, and that the underlying components that determine the value of
the option may change during that time. time value is generally equal to the difference between the premium
and the intrinsic value. Related: in-the-money.

NPV (net present value of cash flows)

Same as PV, but usually includes a subtraction for an initial cash outlay.

PV (present value of cash flows)

the value in today’s dollars of cash flows that occur in different time periods.
present value factor equal to the formula 1/(1 - r)n, where n is the number of years from the valuation date to the cash flow and r is the discount rate.
For business valuation, n should usually be midyear, i.e., n = 0.5, 1.5, . . .

Abandonment option

The option of terminating an investment earlier than originally planned.

Adjusted present value (APV)

The net present value analysis of an asset if financed solely by equity
(present value of un-levered cash flows), plus the present value of any financing decisions (levered cash
flows). In other words, the various tax shields provided by the deductibility of interest and the benefits of
other investment tax credits are calculated separately. This analysis is often used for highly leveraged
transactions such as a leverage buy-out.

American option

An option that may be exercised at any time up to and including the expiration date.
Related: European option

American-style option

An option contract that can be exercised at any time between the date of purchase and
the expiration date. Most exchange-traded options are American style.

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Asian option

option based on the average price of the asset during the life of the option.

Bargain-purchase-price option

Gives the lessee the option to purchase the asset at a price below fair market
value when the lease expires.

Barrier options

Contracts with trigger points that, when crossed, automatically generate buying or selling of
other options. These are very exotic options.

Basket options

Packages that involve the exchange of more than two currencies against a base currency at
expiration. The basket option buyer purchases the right, but not the obligation, to receive designated
currencies in exchange for a base currency, either at the prevailing spot market rate or at a prearranged rate of
exchange. A basket option is generally used by multinational corporations with multicurrency cash flows
since it is generally cheaper to buy an option on a basket of currencies than to buy individual options on each
of the currencies that make up the basket.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

Bond value

With respect to convertible bonds, the value the security would have if it were not convertible
apart from the conversion option.

Book value

A company's book value is its total assets minus intangible assets and liabilities, such as debt. A
company's book value might be more or less than its market value.

Book value per share

The ratio of stockholder equity to the average number of common shares. Book value
per share should not be thought of as an indicator of economic worth, since it reflects accounting valuation
(and not necessarily market valuation).

Break-even time

Related: Premium payback period.

Call an option

To exercise a call option.

Call option

An option contract that gives its holder the right (but not the obligation) to purchase a specified
number of shares of the underlying stock at the given strike price, on or before the expiration date of the
contract.
Call premium
Premium in price above the par value of a bond or share of preferred stock that must be paid to
holders to redeem the bond or share of preferred stock before its scheduled maturity date.

Carrying value

Book value.

Cash flow time-line

Line depicting the operating activities and cash flows for a firm over a particular period.

Cash-surrender value

An amount the insurance company will pay if the policyholder ends a whole life
insurance policy.

Compound option

option on an option.

Conversion value

Also called parity value, the value of a convertible security if it is converted immediately.

Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies

Currency option

An option to buy or sell a foreign currency.

Dealer options

Over-the-counter options, such as those offered by government and mortgage-backed
securities dealers.

Delivery options

The options available to the seller of an interest rate futures contract, including the quality
option, the timing option, and the wild card option. Delivery options make the buyer uncertain of which
Treasury Bond will be delivered or when it will be delivered.

Doubling option

A sinking fund provision that may allow repurchase of twice the required number of bonds
at the sinking fund call price.

Down-and-in option

Barrier option that comes into existence if asset price hits a barrier.

Down-and-out option

Barrier option that expires if asset price hits a barrier.

Elasticity of an option

Percentage change in the value of an option given a 1% change in the value of the
option's underlying stock.

Embedded option

An option that is part of the structure of a bond that provides either the bondholder or
issuer the right to take some action against the other party, as opposed to a bare option, which trades
separately from any underlying security.

Equity options

Securities that give the holder the right to buy or sell a specified number of shares of stock, at
a specified price for a certain (limited) time period. Typically one option equals 100 shares of stock.

European option

option that may be exercised only at the expiration date. Related: american option.

European-style option

An option contract that can only be exercised on the expiration date.

Exercise value

The amount of advantage over a current market transaction provided by an in-the-money
option.

Exercising the option

The act buying or selling the underlying asset via the option contract.

Expected value

The weighted average of a probability distribution.

Expected value of perfect information

The expected value if the future uncertain outcomes could be known
minus the expected value with no additional information.

Extraordinary positive value

A positive net present value.

Face value

See: Par value.

Firm's net value of debt

Total firm value minus total firm debt.

Foreign currency option

An option that conveys the right to buy or sell a specified amount of foreign
currency at a specified price within a specified time period.

Future value

The amount of cash at a specified date in the future that is equivalent in value to a specified
sum today.

Futures option

An option on a futures contract. Related: options on physicals.

Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

Greenshoe option

option that allows the underwriter for a new issue to buy and resell additional shares.

Index and Option Market (IOM)

A division of the CME established in 1982 for trading stock index
products and options. Related: Chicago Mercantile Exchange (CME).

Index option

A call or put option based on a stock market index.

Intrinsic value of an option

The amount by which an option is in-the-money. An option which is not in-themoney
has no intrinsic value. Related: in-the-money.

Intrinsic value of a firm

The present value of a firm's expected future net cash flows discounted by the
required rate of return.

Investment value

Related:straight value.

Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).

Just-in-time inventory systems

Systems that schedule materials/inventory to arrive exactly as they are
needed in the production process.

Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill

Liquidation value

Net amount that could be realized by selling the assets of a firm after paying the debt.

Loan value

The amount a policyholder may borrow against a whole life insurance policy at the interest rate
specified in the policy.

Lookback option

An option that allows the buyer to choose as the option strike price any price of the
underlying asset that has occurred during the life of the option. If a call, the buyer will choose the minimal
price, whereas if a put, the buyer will choose the maximum price. This option will always be in the money.

Liquid yield option note (LYON)

Zero-coupon, callable, putable, convertible bond invented by Merrill Lynch & Co.

Margin requirement (Options)

The amount of cash an uncovered (naked) option writer is required to
deposit and maintain to cover his daily position valuation and reasonably foreseeable intra-day price changes.

Market timer

A money manager who assumes he or she can forecast when the stock market will go up and down.

Market value

1) The price at which a security is trading and could presumably be purchased or sold.
2) The value investors believe a firm is worth; calculated by multiplying the number of shares outstanding by the
current market price of a firm's shares.

Market value ratios

Ratios that relate the market price of the firm's common stock to selected financial
statement items.

Market value-weighted index

An index of a group of securities computed by calculating a weighted average
of the returns on each security in the index, with the weights proportional to outstanding market value.

Maturity value

Related: par value.

Multi-option financing facility

A syndicated confirmed credit line with attached options.

Naked option strategies

An unhedged strategy making exclusive use of one of the following: Long call
strategy (buying call options ), short call strategy (selling or writing call options), Long put strategy (buying
put options ), and short put strategy (selling or writing put options). By themselves, these positions are called
naked strategies because they do not involve an offsetting or risk-reducing position in another option or the
underlying security.
Related: covered option strategies.

Net adjusted present value

The adjusted present value minus the initial cost of an investment.

Net asset value (NAV)

The value of a fund's investments. For a mutual fund, the net asset value per share
usually represents the fund's market price, subject to a possible sales or redemption charge. For a closed end
fund, the market price may vary significantly from the net asset value.

Net book value

The current book value of an asset or liability; that is, its original book value net of any
accounting adjustments such as depreciation.

Net present value (NPV)

The present value of the expected future cash flows minus the cost.

Net present value of growth opportunities

A model valuing a firm in which net present value of new
investment opportunities is explicitly examined.

Net present value of future investments

The present value of the total sum of NPVs expected to result from
all of the firm's future investments.

Net present value rule

An investment is worth making if it has a positive NPV. Projects with negative NPVs
should be rejected.

Net salvage value

The after-tax net cash flow for terminating the project.

Option

Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a
given date. Investors, not companies, issue options. Investors who purchase call options bet the stock will be
worth more than the price set by the option (the strike price), plus the price they paid for the option itself.
Buyers of put options bet the stock's price will go down below the price set by the option. An option is part of
a class of securities called derivatives, so named because these securities derive their value from the worth of
an underlying investment.

Option elasticity

The percentage increase in an option's value given a 1% change in the value of the
underlying security.

Option not to deliver

In the mortgage pipeline, an additional hedge placed in tandem with the forward or
substitute sale.

Option premium

The option price.

Option price

Also called the option premium, the price paid by the buyer of the options contract for the right
to buy or sell a security at a specified price in the future.

Option seller

Also called the option writer , the party who grants a right to trade a security at a given price in
the future.

Option writer

option seller.

Option-adjusted spread (OAS)

1) The spread over an issuer's spot rate curve, developed as a measure of
the yield spread that can be used to convert dollar differences between theoretical value and market price.
2) The cost of the implied call embedded in a MBS, defined as additional basis-yield spread. When added to the
base yield spread of an MBS without an operative call produces the option-adjusted spread.

Options contract

A contract that, in exchange for the option price, gives the option buyer the right, but not
the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a
specified time period, or on a specified date (expiration date).

Options contract multiple

A constant, set at $100, which when multiplied by the cash index value gives the
dollar value of the stock index underlying an option. That is, dollar value of the underlying stock index = cash
index value x $100 (the options contract multiple).

Options on physicals

Interest rate options written on fixed-income securities, as opposed to those written on
interest rate futures contracts.

Original face value

The principal amount of the mortgage as of its issue date.

Out-of-the-money option

A call option is out-of-the-money if the strike price is greater than the market price
of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of
the underlying security.

Par value

Also called the maturity value or face value, the amount that the issuer agrees to pay at the maturity date.

Parity value

Related:conversion value

Path dependent option

An option whose value depends on the sequence of prices of the underlying asset
rather than just the final price of the asset.

Postponement option

The option of postponing a project without eliminating the possibility of undertaking it.

Present value

The amount of cash today that is equivalent in value to a payment, or to a stream of payments,
to be received in the future.

Present value factor

Factor used to calculate an estimate of the present value of an amount to be received in
a future period.

Present value of growth opportunities (NPV)

Net present value of investments the firm is expected to make
in the future.

Price value of a basis point (PVBP)

Also called the dollar value of a basis point, a measure of the change in
the price of the bond if the required yield changes by one basis point.

Put an option

To exercise a put option.

Put option

This security gives investors the right to sell (or put) fixed number of shares at a fixed price within
a given time frame. An investor, for example, might wish to have the right to sell shares of a stock at a certain
price by a certain time in order to protect, or hedge, an existing investment.

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